Do companies purchase life insurance policies?
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UPDATED: Jul 24, 2011
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Individuals are not the only ones who purchase life insurance policies. Often, businesses will purchase policies for various reasons. In each case, the company makes a decision to purchase policies because of some perceived benefit to itself.
Buying Life Insurance as a Company Investment
In the simplest cases, businesses purchase insurance to insure the life of an important employee, such as a CEO or board member. The rationale is that the loss of this person’s service would severely affect the company’s viability or financial stability, so the company has the right to insure him or her to recoup perceived losses.
This practice is called “key employee” insurance, and it is very common with larger corporations. However, there are certain laws and regulations which limit this practice and the amounts for which employees can be insured. At one time, some companies insured all of their employees, in a system called “dead peasant” insurance. However, in 2006 this practice was legislated, due to the fact that many companies were using it to create interest deductions rather than actually being interested in collecting life insurance proceeds.
Buying Life Insurance from Terminally Ill Individuals
In some cases, an investment company will purchase life insurance policies from individuals. The most common reason for this is that the individual is terminally ill and needs cash for medical or other expenses. Because the individual needs the cash immediately, he or she is often willing to “sell” the policy for less than the face value. This is not a loan; rather, the individual will name the company as the beneficiary of the policy and agree to keep the policy current until death. At that point, the company will claim the death benefit, thereby recouping its investment plus any profit. This type of purchase is called “viatical settlement,” and has increased sharply in the last thirty years.
Life insurance companies are not happy with this practice, for a very simple reason. Life insurance rates are based on risk. Actuaries determine the price paid for insurance based on age, health, and other factors. While insurance companies know that they will have to pay some claims due to the untimely deaths of younger clients, for the most part they will be able to recoup these losses by raising premiums as clients age, and by charging higher premiums for new clients who are older or have health issues. Because an investment company is guaranteed a payout with a terminally ill person, insurance companies feel that they are taking all the risk and these companies are making the profit. Many companies now have “viatical settlement” clauses which disallow the sale of the policy to a third-party interest.
Do Life Insurance Companies buy back policies?
Another reason a company may purchase insurance is when an insurance company buys back its own policy. In this case, the insured may receive a portion of the premiums which have been paid in return for surrendering the policy. This type of buy back may occur when something changes with the insured, such as an unexpected health issue, which changes the terms of the policy. Some companies are also more willing to work with people who have a reverse in financial circumstances, such as a job loss or bankruptcy. These companies may feel that it is better to refund some of the premiums and keep good will with the customers, so that if they are able to purchase life insurance again, they may return as customers.
Life Insurance for Employees
A company may also purchase life insurance for its employees. It is very common for companies to offer group policies to its workers. While the workers pay the premiums, these are generally much lower than they could get buying individually, because the risk pool is spread over a large group of people. In theory, because the employee group is made up of people of all ages and health conditions, the risk overall is lowered for the insurance company. Businesses will often help to subsidize premiums to keep them lower for their employees as a benefit. Often, businesses will match a life insurance purchase by paying the premium necessary to increase the coverage. This makes the business more attractive to potential workers.
Group policies do have some limitations. Most group coverage only pays in the event of certain types of deaths, with several exclusionary clauses. Group policies are often limited to lump-sum payments, although annuities are available in some cases. However, group policies have the advantage, in most states, of being excluded from estate tax based on ownership. Because the company in essence purchases the policy and pays part of the premium, most states do not consider employment-based group insurance to be owned by the insured, thereby exempting it from estate tax.